Wharton 1995 Survey of Derivative Usage by U.S. Non-Financial Firms

Financial Management
Vol. 25, No. 4,  1996

EXECUTIVE SUMMARY

This is the second year that the Wharton School has conducted a survey of derivatives and risk management practice by non-financial corporations in the United States. The 1995 survey is more detailed than the survey conducted in 1994, with a broader range of questions about valuation and risk measurement and with more specific questions about the use of derivatives. Questionnaires were mailed in October 1995 to the same randomly selected set of firms used in the 1994 survey plus the remaining Fortune 500 firms not included in the 1994 sample. A total of 350 firms responded to the survey: 176 firms in the manufacturing sector, 77 firms in the primary products sector, and 97 firms from the service sector.

Among the more interesting findings are:

o 142 of the firms (or 40.5%) reported using derivatives. There is no evidence that the use of derivatives has declined as a result of the well-publicized losses on derivatives suffered by a few corporations. Among the random sample of firms common to the 1994 and 1995 surveys, there is actually a small increase in the use of derivatives.

o Derivatives are primarily used for risk management purposes, with most firms indicating that management of fluctuations in cash flows (49%) or accounting earnings (42%) is their primary objective of hedging. Much less important were the objectives of managing the market value of the firm or the appearance of the balance sheet.

o Yet many firms alter their derivatives positions based on a "market view" A relatively large number of firms will "sometimes" incorporate their market view into hedging decisions, with 61% of firms sometimes altering the timing of their hedges and 48% sometimes altering the size of their hedges. What is more surprising is the large percentage of firms that indicate that they "actively take positions" based on a market view of interest rates or exchange rates. While only 3% and 6% of firms "frequently" take positions on interest rates and exchange rates, respectively, over a third of all derivatives users do so at least "sometimes".

o The three issues causing the most concern among derivative users are credit risk (of counterparties), problems in evaluating the risk of derivative transactions, and uncertainty about accounting treatment. Each of these issues had over 30% of derivative users indicating a high degree of concern.

o How well do firms oversee the use of derivatives? 76% of the firms using derivatives have a documented policy with respect to use of derivatives, and 49% of the firms regularly report on derivatives to their boards of directors. But 16% of the firms neither have a documented policy nor report regularly to their boards of directors.

o How frequently do firms revalue their derivatives positions? A significant proportion of firms - 27% - revalue either daily or weekly, and another 38% revalue monthly. But 42% rely on the originating dealer as the primary source for the revaluations, a practice which has been criticized recently.

o Corporate risk measurement of derivative positions seems to be far more advanced than previously thought. The survey asked whether firms were using any of four methods of risk measurement: "value-at-risk", stress testing or scenario analysis, option sensitivity measures, and duration or price value of a basis point. 64% of the firms using derivatives reported using one or more of these methods. 35% of the firms reported using value-at-risk measures even though we are aware of only two firms reporting value-at-risk numbers in their annual reports.

o While new requirements for firms to make disclosures about their derivative activity do not seem to bother derivatives users, 57% of derivatives users indicate that the current rules regarding the accounting treatment of derivatives as hedges are causing them to alter their actual use of derivatives from what would otherwise be optimal.

o Why some firms do not use derivatives may be as revealing as why other firms use them, so in this year's survey, we asked firms that do not use derivatives why they refrain from using them. 65% of the firms indicate that an important reason is that their exposures are simply not large enough. However, 39% of firms cite concerns about the perception of derivative use by the public, investors, and regulators as a significant reason for not using derivatives, while 37% cite a lack of knowledge about derivatives as a reason for non-use. So there remains a significant number of firms that might benefit from the use of derivatives yet currently refrain from using them.